For the past several years, it’s been easy for all but the most conservative investors to avoid Guaranteed Investment Certificates (GICs). That’s because interest rates were so low most GICs couldn’t even keep pace with inflation, leaving little to no opportunity for growth.

However, with interest rates rising sharply over the past year, investors have been able to purchase GICs with rates above 5%, with some approaching 6%. And while the inflation rate also rose sharply during the same period, inflation is now tracking downward, well below the 5% some GICs offer.

And while the stock market has outperformed expectations in 2023, with a possible recession looming, many investors are choosing to park their money in GICs. After all, a 5% return with a 100% principal guarantee sounds hard to beat. Or is it?

In this article, I’ll compare GICs and mutual funds. I’ll let you know the pros and cons of each and help you decide where to invest.

What Is a GIC?

A Guaranteed Investment Certificate (GIC) is a low-risk investment product that guarantees a return on your principal investment. With a GIC, you deposit money into a financial institution for a fixed period, and in return, you earn interest on your investment at a predetermined interest rate. This interest can be paid at a fixed or variable rate, making GICs a popular choice for fixed-income investors.

As a low-risk investment, GICs are an attractive option for those looking for a stable and predictable return on their money. The interest rate is agreed upon at the time of your initial investment, and your principal investment is guaranteed, so you know exactly how much you will earn in interest when your GIC reaches maturity.

GICs are available in various forms, including cashable GICs. Cashable GICs allow you to withdraw your money before the end of the GIC term without a penalty, giving you some flexibility in accessing your funds if needed. Regular GICs, on the other hand, are fully locked-in and cannot be withdrawn without a penalty being charged. Upon maturity, you may access your funds, including the interest earned, at any time.

Most Canadian financial institutions allow you to purchase GICs in a non-registered or registered account, such as a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP).

GIC Pros and Cons

As an investor, you might be tempted to use GICs to diversify your portfolio, especially at their current rates. But GICs have drawbacks you need to consider. Here’s my list of GIC pros and cons:

Pros 

Low risk: Generally, GICs are less risky than mutual funds. Your principal investment is guaranteed, so you don’t have to worry about losing your capital.

Guaranteed returns: GICs offer fixed interest rates, ensuring that you will receive a consistent return during the term of your investment. This makes GICs an excellent choice for cautious investors.

Flexible options: GICs come in various forms, including cashable GICs, stepper GICs, market-linked GICs, etc. You can purchase GICs with terms ranging from 30 days to 5 years.

Lower fees: Compared to mutual funds, GICs tend to have lower overhead costs and expenses, making them an attractive investment choice for cost-conscious investors.

Cons

Lower returns: While GIC rates have increased sharply in the past 12 months, they offer less return potential than market investments due to their guaranteed nature and low-risk profile. As the saying goes, “No risk, no reward.”

Inflation risk: GICs are not immune to inflation risk. When the inflation rate is higher than the interest rate you’re receiving from your GIC, your real return could be eroded, impacting your purchasing power in the long run.

Limited liquidity: While cashable GICs offer some flexibility, non-cashable GICs can tie up your funds for the term, making them less liquid than other investment options.

What Is a Mutual Fund?

Mutual funds are professionally managed investments that pool money from multiple investors. The funds are invested in various asset classes, such as stocks, bonds, and other securities.

A mutual fund can reduce the risk of putting all your money into one investment. When you invest in a mutual fund, your money is managed by professional fund managers who make investment decisions based on the fund’s objectives.

There are different types of mutual funds to suit your risk tolerance. For example, if you have a lower risk tolerance, you might consider a bond fund or a money market mutual fund. These funds generally focus on investments with lower volatility and more predictable returns.

On the other hand, if you have a higher risk tolerance, you may invest in a stock mutual fund that invests in the stock market. These funds can provide higher returns, but they come with more risk.

Mutual Funds Fees

Fees are a critical aspect to consider when investing in mutual funds. All mutual funds charge management fees, expressed by the Management Expense Ratio, or MER.

Management fees cover the cost of managing and operating the investment portfolio. Management fees can vary depending on the type of mutual fund and the level of service the fund manager provides. One of the knocks against mutual funds is that the fees on actively traded mutual funds are high and can take a bite out of investment returns, especially over the long run.

Over the past decade, many investors have moved away from actively traded funds toward low-cost index mutual funds and exchange-traded funds (ETFs), which have much lower fees.

Mutual Fund Pros and Cons

As with any investment, you should weigh mutual funds’ pros and cons before investing. 

Pros:

Diversification: By investing in large baskets of individual securities, mutual funds make it easy to diversify your investment.

Small Initial Investment: Mutual funds often have low minimum investment requirements, allowing you to start investing with a smaller amount of money.

Professional Management: Mutual funds employ teams of professional money managers to oversee your investments, giving you more time to focus on other things in your life.

Investment Options: With many choices ranging from sector-specific funds to broad-market index funds, you can tailor your investments to your goals and preferences.

Cons:

High Management Fees: Actively traded mutual funds can charge MERS of 2% or higher annually, lowering overall returns.

You can lose money: Mutual funds invest in the stock market, and your principal is not guaranteed. Your investment will fluctuate in value, and there is the potential that you could lose money.

Capital Gains Tax: In a taxable account, gains from selling assets within the fund may trigger capital gains tax, affecting your overall returns.

You Have Less Control: Since professionals manage the fund, you won’t have the flexibility to manage your investment daily.

GICs vs. Mutual Funds: Similarities

While GICs and mutual funds are very different products, some similarities exist.

1. GICs and mutual funds can be held in registered or non-registered accounts. You can use both in registered accounts like RRSPs and TFSAs or store them in non-registered accounts.

2. GICs and mutual funds are both offered by a wide range of financial institutions. This gives you the flexibility to select the best-fit institution for your investments.

GICs and mutual funds aim to provide you with a positive return on your investment. For GICs, the return is based on the length of the term and the type of GIC, while with mutual funds, your return depends on the performance of the underlying assets.

GICs vs. Mutual Funds: Differences

With GICs and mutual funds, there are more differences than similarities.

1. GICs are safety investments that protect your principal. Most GICs in Canada are protected with deposit insurance coverage from the Canada Deposit Insurance Corporation. Mutual funds, on the other hand, fluctuate in value and are not guaranteed.

2. GICs offer you a guaranteed return for a predetermined period. Except for market-linked GICs, whose returns are linked to an underlying stock market index, you know what your return will be at the time of purchase. With mutual funds, returns are tied to the performance of the underlying stocks and bonds held by the fund, so you have no idea what your returns will be in advance.

3. Mutual funds offer more potential for long-term growth. Over the long term, mutual fund investments should outperform GIC returns. While anything can happen in a given year, the potential for growth in the stock market is far greater than in cash or GICs.

4. Mutual funds charge fees. When you buy a GIC, there are no fees; 100% of your money is invested. All mutual funds charge fees to cover the management and administration costs of the fund. And depending on how you buy mutual funds, you may be subject to paying a trading or commission fee if buying through an investment advisor.

Who Are GICs Best Suited For?

If you’re seeking a secure investment with guaranteed returns, GICs may be a suitable option. And while I don’t recommend GICs to long-term investors whose primary goal is capital growth, GICs may be a good place for your short-term savings or to park money that you’re not ready to invest – especially with interest rates as high as they currently are.

Who Are Mutual Funds Best Suited For?

Mutual funds are often better for those seeking long-term capital growth, as they can offer higher potential returns over time. Remember that your investment is not guaranteed, and your returns may fluctuate with market conditions. Mutual funds may be more suitable for you if you have a longer time horizon and can withstand market ups and downs.

Mutual funds are also beneficial if you need liquidity. For example, if you want a safe investment but can’t have your funds locked into a GIC, you may want to consider purchasing a Money Market mutual fund. While your principal is not guaranteed, money market mutual funds are considered a safe investment and don’t typically fluctuate in value. They offer a decent short-term return, with the ability to redeem your investment at any time by selling your fund units.

ETFs vs. Mutual Funds

If you’re considering investing in an actively traded mutual fund, which strives to outperform overall market returns, you may want to consider investing in an index fund instead – either an index mutual fund or an ETF. These funds are passively managed and have much lower fees, on average. For example, you can purchase a broad market index ETF with an MER below 0.05% annually. Compare that to many active mutual funds with MERs of 2% or higher.

FAQs

How do GICs and mutual funds compare in terms of fees?

GICs usually have no fees associated with their purchase. However, you may face penalties if you withdraw your investment before the term ends. On the other hand, mutual funds often have management fees, known as the Management Expense Ratio (MER), which covers the costs of managing and administering the fund. Additionally, some mutual funds carry sales charges, such as front-end or back-end loads.

Can I withdraw my investments anytime in GICs and mutual funds?

For GICs, withdrawing your investment before the end of the term may result in penalties. However, some GICs are cashable or redeemable, allowing early withdrawal with minimal or no penalties after a short locked-in period. Mutual funds typically offer more flexibility, as you can redeem your shares at any time at the current net asset value (NAV). However, be aware of potential deferred sales charges or other fees associated with early withdrawal.

What are the liquidity differences?

GICs have a fixed term, making them less liquid than mutual funds. They generally require you to keep your investment locked in until the end of the term, though cashable and redeemable GICs offer more liquidity. Mutual funds, however, provide daily liquidity, allowing you to buy and sell shares quickly and easily, making them a more liquid investment option.